The central bank, ahead of a Senate subcommittee hearing on the issue tomorrow, says it’s reviewing a decade-old ruling to let deposit-taking banks trade physical commodities. A reversal would be the Fed’s biggest exclusion of banks from a market since Congress lifted the Depression-era law against them joining with securities firms in 1999.

“Like any regulator, the Fed doesn’t like reversing a long line of decisions,” said Saule T. Omarova, a law professor with the University of North Carolina at Chapel Hill, who’s scheduled to testify at tomorrow’s hearing. “If they get enough pressure from the outside they might be forced to do so.”

The 10 largest Wall Street banks generated about $6 billion in revenue from commodities in 2012, including dealings in physical materials as well as related financial products, according to a Feb. 15 report from analytics company Coalition. Goldman Sachs ranked No. 1, followed by New York-based JPMorgan.

Goldman Sachs held $7.7 billion of commodities at fair value as of March 31 and New York-based Morgan Stanley had $6.7 billion, according to regulatory filings. None of the banks disclose how much revenue or profit comes from commodity trading or break out the contribution from physical assets.

Reviewing 2003

“The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies,” Barbara Hagenbaugh, a Fed spokeswoman, said on July 19. She declined to elaborate.

A subcommittee of the Senate Banking, Housing & Urban Affairs Committee will hear tomorrow whether financial firms such as New York-based Goldman Sachs and Morgan Stanley should continue to be allowed to store, ship and own physical assets like metal and oil. At a time when JPMorgan faces a potential fine for alleged manipulation of U.S. energy prices, the panel will discuss possible conflicts of interest in the business model, said its chairman, U.S. Senator Sherrod Brown, an Ohio Democrat.

“When Wall Street banks control the supply of both commodities and financial products, there’s a potential for anti-competitive behavior and manipulation,” Brown said in an e-mailed statement. Goldman Sachs, Morgan Stanley and JPMorgan are the biggest Wall Street players in physical commodities.

‘Enough Pressure’

When the Fed gave JPMorgan approval in 2005 for hands-on involvement in commodity markets, it prohibited the bank from expanding into the storage business because of the risk.

Five years later, JPMorgan bought one of the world’s biggest metal warehouse companies. The Fed never explained why it let that happen.

That’s one reason the new review is so surprising, according to Marcus Stanley, policy director at nonprofit group Americans for Financial Reform.

“Given their silence on this issue for so long, this is important,” Stanley said. “There’s going to be some activity among the bank lobbyists over the next couple of days.”

On June 27, four Democratic members of Congress wrote a letter asking Fed Chairman Ben S. Bernanke, among other things, how examiners would account for possible bank runs caused by a bank-owned tanker spilling oil, and how the regulator would resolve a systemically important financial institution’s commodities activities if it were to collapse.

Hearing Critics

The Fed’s re-examination of its policy shows the central bank isn’t deaf to criticism, said Joshua Rosner, managing director at New York-based research firm Graham Fisher & Co. and another witness scheduled to testify tomorrow.

“Given the inconsistencies on its oversight on these issues, the Fed seems to be trying to cover its backside,” Rosner said.

For more than 50 years, the Bank Holding Company Act prevented federally guaranteed lenders, such as JPMorgan, from direct participation in commodity markets. The prohibition didn’t pertain to Goldman Sachs and Morgan Stanley, which were investment banks, until they became bank holding companies in 2008. After that, the Fed gave both firms a five-year grace period, which expires in September, while regulators decided whether to curtail their activities related to metals, fuels and other goods.

‘Virtually Impossible’

Now, “it is virtually impossible to glean even a broad overall picture of Goldman Sachs’s, Morgan Stanley’s, or JPMorgan’s physical commodities and energy activities from their public filings with the Securities and Exchange Commission and federal bank regulators,” Omarova wrote in a November 2012 academic paper, “Merchants of Wall Street: Banking, Commerce and Commodities.”

The added complexity makes the financial system less stable and more difficult to supervise, she said in an interview.

“It stretches regulatory capacity beyond its limits,” Omarova said. “No regulator in the financial world can realistically, effectively manage all the risks of an enterprise of financial activities, but also the marketing of gas, oil, electricity and metals. How can one banking regulator develop the expertise to know what’s going on?”